Europe’s deflation risk

Click to enlarge

The OECD does not see deflation taking hold in the euro area, but the risk has risen.

Consumer prices are now barely rising in the euro area. Could the current low positive rate of inflation give way to a period of deflation, and if so, why would that matter?

Euro area inflation has been falling steadily for three years (chart 1), confounding the expectations of financial markets and economic forecasters. In September 2014, the euro area inflation rate was just 0.3% year on year, and inflation rates were negative in six euro area countries, three of which recorded falling consumer prices for the third month in a row. Persistent economic slack and the recent decline in energy prices were largely to blame, though structural reforms to boost competition and regain competitiveness in peripheral countries also contributed.

Clearly, the risk that consumer price inflation will slip into negative territory has risen, and the consequences of such an outcome could be serious.

The worry is that deflation would aggravate the weakness of demand in the euro area, in several ways.

First, falling prices mean that real interest rates (nominal rates adjusted for price increases) can get stuck at excessively high levels as monetary policy is constrained by the zero lower bound.

Deflation also raises the real value of a given nominal stock of debt, so the burden of debt for public and private borrowers increases, while wealth is shifted to creditors. As creditors often save much of their extra real income while borrowers typically have higher propensities to spend, the result is generally lower total spending.

Moreover, with prices expected to fall, deflation may also encourage consumers to postpone their spending.

Finally, negative inflation generally means that necessary adjustments in relative real wages between sectors or regions can only be achieved via widespread cuts in nominal wages. Such reductions tend to occur only when economic conditions are very depressed, as people become more concerned about keeping their jobs than maintaining their wage.

Deflation is not unknown in the OECD area. The most recent major example is Japan, which was mired in deflation for over one and a half decades, and where inflation has only recently moved back into positive territory (chart 2). Switzerland has also had negative annual inflation for much of the past three years. In the euro area, Greece, Ireland, Portugal and Spain all experienced periods of falling prices during the crisis, which, together with sharply lower commodity prices, helped push inflation briefly below zero in the euro area as a whole.

The current risk of euro area deflation represents a greater economic threat than the earlier transitory episode in a context of plunging commodity prices. In fact, low inflation is already having a negative impact. Given that countries in the euro area have a shared currency and cannot use the nominal exchange rate as an instrument to reduce external imbalances between the member states, necessary adjustments have to take place via differential growth in nominal wages and prices. But when nominal wage increases are very low throughout the euro area, a country can only achieve a reduction in its relative wage level via falling nominal wages. And, as already noted, nominal wage reductions tend only to be possible in very depressed economic conditions. It is no coincidence that the largest drops in wages to date have occurred in economies like Greece and Spain where unemployment has risen to extremely high levels.

Very low inflation also makes fiscal consolidation more politically difficult. Some countries are freezing nominal expenditure as a way of achieving real spending cuts via inflation, but such moves yield only limited budgetary gains in a low inflation environment.

Click to enlarge

Despite the risks, the OECD does not expect the euro area to fall into deflation. The European Central Bank (ECB) is committed to use unconventional instruments within its mandate to avoid a prolonged period of low inflation, and the measures it has announced since June should help. The ongoing shift in monetary policy in the United States, combined with a move towards greater easing in the euro area, has already resulted in a depreciation of the euro against the dollar, and such depreciation puts upward pressure on the price level in Europe. In addition, the drag on demand from fiscal consolidation is now easing. As demand strengthens, inflation should turn back up towards the ECB’s target range, although it is likely to remain well below that target for some time yet.

But if deflation is not the OECD’s central scenario, complacency would be misplaced. True, long-term inflation expectations have appeared well-anchored around the ECB’s definition of price stability. However, the experience of Japan in the 1990s, when similar measures of long-term inflation expectations consistently failed to predict deflation 5-10 years ahead, is sobering. As actual inflation fell, long-term expectations did adjust downward, but even once deflation had taken hold in Japan, expectations about future inflation were still (wrongly) positive. The longer that actual inflation remains far below 2%, the more likely it is that long-term expectations will become de-anchored from the ECB’s objective, making it even more difficult to return to the target range.

This article was prepared by the OECD Economics Department for the OECD Observer, October 2014. can be contacted for further commentary.


©OECD Observer No 300, Q3 2014


G20 Brisbane 2014

Deflation watch

Economic data


Stay up-to-date with the latest news from the OECD by signing up for our e-newsletter :

Twitter feed

Suscribe now

<b>Subscribe now!</b>

To receive your exclusive print editions delivered to you directly

Online edition
Previous editions

Don't miss

  • How sustainable is the ocean as a source of economic development? The Ocean Economy in 2030 examines the risks and uncertainties surrounding the future development of ocean industries, the innovations required in science and technology to support their progress, their potential contribution to green growth and some of the implications for ocean management.
  • OECD Environment Director Simon Upton presented a talk at Imperial College London on 21 April 2016. With the world awash in surplus oil and prices languishing around US$40 per barrel, how can governments step up efforts to transform the world’s energy systems in line with the Paris Agreement?
  • Happy 10th birthday to Twitter. This 2008 OECD Observer interview with Henry Copeland said you’d do well.
  • The OECD Gender Initiative examines existing barriers to gender equality in education, employment, and entrepreneurship. The gender portal monitors the progress made by governments to promote gender equality in both OECD and non-OECD countries and provides good practices based on analytical tools and reliable data.
  • Once migrants reach Europe, countries face integration challenge: OECD's Thomas Liebig speaks to NPR's Audie Cornish.
  • “Un Automne à Paris”: listen (and read) this sad yet uplifting new song by jazzman Ibrahim Maalouf and pop singer Louane that will be launched on 11 January in honour of the victims of the murderous attacks on the French capital in 2015 and as a tribute to love and liberty in this City of Light.

  • Secretary-General Angel Gurria on CNBC: Developed vs developing nations at COP21

  • Message from the International Space Station to COP21

  • COP21 Will Get Agreement With Teeth: OECD Secretary-General Angel Gurría on Bloomberg

  • The carbon clock is ticking: OECD’s Gurría on CNBC

  • If we want to reach zero net emissions by the end of the century, we must align our policies for a low-carbon economy, put a price on carbon everywhere, spend less subsidising fossil fuels and invest more in clean energy. OECD at #COP21 – OECD statement for #COP21
  • They are green and local --It’s a new generation of entrepreneurs in Kenya with big dreams of sustainable energy and the drive to see their innovative technologies throughout Africa.
  • Pole to Paris Project
  • Black carbon causes millions of deaths every year and contributes to the warming of the planet. The United Nations Environment Programme explains how reducing black carbon can save lives and help combat climate change.
  • In order to face global warming, Asia needs at least $40 billion per year, derived from both the public and private sector. Read how to bridge the climate financing gap on the Asian Bank of Development's website.
  • How can cities fight climate change?
    Discover projects in Denmark, Canada, Australia, Japan and Mexico.
  • Climate: What's changed, what hasn't, what we can do about it.
    Lecture by OECD Secretary-General Angel Gurría, hosted by the London School of Economics and Aviva Investors in association with ClimateWise, London, UK, 3 July 2015.
  • French Economy Minister Emmanuel Macron came to the OECD on 18 September for a webcast discussion on economic reforms, inequality and the outlook, with OECD Secretary-General Angel Gurría. You can watch the event by clicking on the photo.

  • Climate change: “We should not disagree when scientists tell us we have a window of opportunity–10-15 years–to turn this thing around” argues Senator Bernie Sanders.

  • In the long-run, the EU benefits from migration, says OECD Head of International Migration Division Jean-Christophe Dumont.
  • Is technological progress slowing down? Is it speeding up? At the OECD, we believe the research from our Future of ‪Productivity‬ project helps to resolve this paradox.
  • An employee prepares breakfast in front of the Eiffel tower at the Parisian luxury hotel Le Plaza Athenee. Nowhere in the world has more accommodation available on Airbnb than Paris. Now the home-sharing website that has transformed budget travel is giving super-deluxe hotels a fright too.
    ©REUTERS/Stephane Mahe
  • Is inequality bad for growth? That redistribution boosts economies is not established by the evidence says FT economics editor Chris Giles. Read more on
  • Low interest rates here to stay for half a century, says OECD director Adrian Blundell-Wignall.
  • Bill Gates visited the OECD on 26 June. He met with the Secretary-General Angel Gurría to discuss areas of collaboration with his foundation and participated at a briefing session on official development assistance modernisation with OECD experts.
  • The People’s Republic of China decided to enhance longstanding collaboration with the OECD and to join the OECD Development Centre, in a historic visit by Chinese Premier Li Keqiang on 1 July to the OECD in Paris.
    Read about it on
  • Catherine Mann, OECD Chief Economist, explains on Bloomberg why "too much bank lending can slow economic growth".
  • Interested in a career in Paris at the OECD? The OECD is a major international organisation, with a mission to build better policies for better lives. With our hub based in one of the world's global cities and offices across continents, find out more at .
  • Come va la vita in Italia? How's life in Italy? The OECD Better Life Index is an interactive online platform in seven languages that goes beyond GDP by offering important insights into measuring well-being and quality of life. Try it for yourself!

Most Popular Articles


What issue are you most concerned about in 2015?

Euro crisis
Global warming
International conflict

OECD Insights Blog

NOTE: All signed articles in the OECD Observer express the opinions of the authors
and do not necessarily represent the official views of OECD member countries.

All rights reserved. OECD 2016